This post describes one of the most important provisions in any LLC operating agreement: a buy-sell agreement.
Forming a limited liability company (LLC) is one of the most popular legal structures for a business. Though corporations are a much older type of entity, LLCs have now become the first type of entity considered by entrepreneurs and business people. This is both due to LLC’s flexibility as well as their less onerous recordkeeping requirements. The majority of our firm’s clients use LLCs. LLCs can be used by everyone from solopreneurs looking to limit their personal liability, to groups of investors needing to create multiple levels of ownership and control.
Buy-sell agreements are one of the most important provisions in LLC operating agreements because they determine what will happen to the company if certain major life events occur for the members. Just as you should have a will or a trust established, a buy-sell agreement addresses what happens to the ownership of the LLC.
A buy-sell agreement is the part of your LLC’s operating agreement addressing when you (or another member) may be legally obligated to buy or sell an interest in the company. The operating agreement will state that if certain events occur, a member’s ownership interest may be bought, or may be required to be sold, to the other members. The most common buy-sell events are when a member has one of the following events occur:
Death
Incapacity
Termination of employment
Retirement
Divorce
Bankruptcy
Sale of a membership/ownership interest
This list is non-exhaustive and an LLC’s owners can decide to require the purchase and sale of a member’s interest upon any conditions that they so desire.
A typical buy-sell agreement will state that if one of the triggering conditions occurs, a member’s ownership interest will be automatically valued according to a certain formula, and then the other members will be allowed to purchase that interest.
For example, a buy-sell provision might say that if a member dies, their ownership interest is appraised at its fair market value by the company’s accountant, and the members can then purchase the interest from the estate of the deceased member, with the price paid in the form of a loan from the member’s estate over a number of years.
Or, a buy-sell provision might state that if a member files for bankruptcy, their ownership interest is determined by the book value of the company (typically, lower than the market value) and the members have to pay the purchase price immediately.
You – as the members forming an LLC and having an attorney draft your operating agreement – have the right to decide what the conditions are under which there is a right to continue owning the company.
Though the buy-sell agreement is often part of the operating agreement, some companies’ members do not choose to include one when they are formed. A buy-sell agreement can still be drafted separately after the company is formed. It is common for an LLC’s members to realize – especially after the company has become successful – that they need to place limits on what will happen if a major life event were to occur for one of them.
A sample buy-sell agreement is linked here: Sample Buy-Sell Agreement. (Please note that this sample is not legal advice and should not be used for your own LLC without the advice of counsel.) In this agreement, if a member wants to transfer their interest to a third party, they must obtain the consent of the other members, who also have a right of first refusal to buy the selling member’s ownership interest. Likewise, if a member dies, the other members have the right to purchase some or all of the interest. The sample lists a few options that an LLC’s members might choose to use for valuing the members’ interest. There are simpler agreements than this sample, and there are more complex ones.
Whether you are forming an LLC or need to update the terms of an existing agreement, it is important to decide what the terms of your buy-sell agreement are.
Dye Culik PC is a Charlotte, North Carolina business law firm with experience representing members of LLCs in all aspects of corporate law, including buy-sell agreements. If you have a question about your company, contact us to see how we can help.